Question 4
Lecture discussion question
With reference to published research discussed in the lectures, critically appraise
following statement:
The use of transfer pricing can exaggerate the achievement of corporate objectives
at the expense of maintaining divisional autonomy and this is likely to result in
behavioural implications.
ANSWER
Transfer prices (TP) was emerged due to the decentralisation of decision making.
EY (2017) defines TP as the price set between companies in the same group when
exchanging goods and services or sharing resources. TP represents an
intracompany market mechanism.
Main purposes of TP include ensuring all resources are allocated in an optimal
manner; providing useful information for managerial decision making and
performance evaluation; moving profits between divisions; and ensuring that
divisional autonomy is not undermined. Schuster and Clarke (2010) allocated the
primary functions of TP into profit allocation function and coordination function.
A good TP should preserve divisional autonomy (Hiromoto, 1983). Goal congruence
can be encouraged through the performance measurement system. TP can
encourage divisions to make decisions to achieve corporate objectives but there
must be an agreement of individuals with the goals (Parker, 2000). With increasing
decentralisation, there has to be a greater focus on achieving goal congruence.
Negotiated TPs work best for goal congruence while market-based TPs work best for
maintaining autonomy (Anderson, 1992).
Generally, companies can determine TP 3 different ways: market-based TP, cost-
based TP, and negotiated TP.
Market-based TPs is used when the market price is known by both divisions and
adjusted by negotiation. It simulates market conditions within the company. The main
advantage is that market-based TPs support and implement corporate strategy and
allow performance measurement using market-oriented data (Schuster and Clarke,
2010). It is objective, unbiased and difficult to manipulate. However, market-based
TP is ideal in a perfectly competitive external market, which is unlikely in practice,
otherwise, dysfunctional decisions may result. Schuster and Clarke (2010) found that
market-based TPs perform the profit-allocation function except when synergies and
interdependencies exist.
Cost-based TP system is considered when there is no external market information. 3
types of cost-based TP are full cost TP, marginal cost TP and full cost plus mark-up
TP. They cover all costs of selling division and full cost plus mark-up may equate to
market price. Marginal or variable cost based TPs are ideal when the selling division
has excess capacity. However, decisions made by managers could be sub-optimal.
Schuster and Clarke (2010) proved that because the TPs do not give the selling
Lecture discussion question
With reference to published research discussed in the lectures, critically appraise
following statement:
The use of transfer pricing can exaggerate the achievement of corporate objectives
at the expense of maintaining divisional autonomy and this is likely to result in
behavioural implications.
ANSWER
Transfer prices (TP) was emerged due to the decentralisation of decision making.
EY (2017) defines TP as the price set between companies in the same group when
exchanging goods and services or sharing resources. TP represents an
intracompany market mechanism.
Main purposes of TP include ensuring all resources are allocated in an optimal
manner; providing useful information for managerial decision making and
performance evaluation; moving profits between divisions; and ensuring that
divisional autonomy is not undermined. Schuster and Clarke (2010) allocated the
primary functions of TP into profit allocation function and coordination function.
A good TP should preserve divisional autonomy (Hiromoto, 1983). Goal congruence
can be encouraged through the performance measurement system. TP can
encourage divisions to make decisions to achieve corporate objectives but there
must be an agreement of individuals with the goals (Parker, 2000). With increasing
decentralisation, there has to be a greater focus on achieving goal congruence.
Negotiated TPs work best for goal congruence while market-based TPs work best for
maintaining autonomy (Anderson, 1992).
Generally, companies can determine TP 3 different ways: market-based TP, cost-
based TP, and negotiated TP.
Market-based TPs is used when the market price is known by both divisions and
adjusted by negotiation. It simulates market conditions within the company. The main
advantage is that market-based TPs support and implement corporate strategy and
allow performance measurement using market-oriented data (Schuster and Clarke,
2010). It is objective, unbiased and difficult to manipulate. However, market-based
TP is ideal in a perfectly competitive external market, which is unlikely in practice,
otherwise, dysfunctional decisions may result. Schuster and Clarke (2010) found that
market-based TPs perform the profit-allocation function except when synergies and
interdependencies exist.
Cost-based TP system is considered when there is no external market information. 3
types of cost-based TP are full cost TP, marginal cost TP and full cost plus mark-up
TP. They cover all costs of selling division and full cost plus mark-up may equate to
market price. Marginal or variable cost based TPs are ideal when the selling division
has excess capacity. However, decisions made by managers could be sub-optimal.
Schuster and Clarke (2010) proved that because the TPs do not give the selling
